The purveyors of attitude to risk questionnaires have made a nice living out of persuading financial advisers that by using such a questionnaire they give better advice and reduce the risk of complaints. I have always been sceptical about this, for two main reasons:
- The FCA does not require advisers to measure the client’s attitude to risk but it does require them to assess the client’s capacity for loss.
- The only way of aligning the output from an ATR questionnaire with investment portfolios is through capacity for loss, which is not aligned with attitudes and requires independent assessment by an adviser.
My firm uses capacity as the primary way of creating risk profiles. After all, what the client (not to mention the OED) means by risk is not volatility but the chance of a permanent loss of capital or income, best measured by historical peak-to-trough declines.
I am delighted to see common sense confirmed in a piece of research for the Pension Institute by two professors, including David Blake (professor of pensions economics at Cass Business School), who has also written on behavioural finance.
The key finding from their research is: “Taken in isolation, a saver’s attitude to risk score is not a good guide to the amount of savings risk a saver is able and willing to take.”
This is because their survey shows there is no relationship between attitude to investment risk and the amount of savings risk (the risk of a shortfall from stated future income goals) people are able and willing to take.
Experienced advisers will know that this statement is true. It reflects a set of behavioural inconsistencies or biases which have been identified by behavioural economics over the past 20 years. People save too little because the present is ‘available’ in the way the future is not, and because they project the kind of conservatism that is appropriate for emergency funds or short-term needs into longer-term goals in the phenomenon referred to as reckless conservatism. Mental accounting – being prepared to adopt different risk-return profiles for different goals – also erodes the usefulness of ATR questionnaires.
This leads Professor Blake to the conclusion that many of those surveyed for his research were prepared to take on far less risk than they should in order to stand a chance of meeting their savings goals.
And he says advisers and regulators ought to nudge people into accepting more risk with their savings rather than reducing ambitions or working for many more years.
My one hope is that this research is read carefully by people at the FCA and the FOS. Partly thanks to their regulations and interpretations of regulations, there has also been an institutional failure to accept the implications of known behavioural biases. As regards their savings for long-term goals, most people without professional financial advice tend to take far too little risk.
A good start for advisers is a non-psychometric questionnaire that elicits responses about not just attitudes but goals, experience, knowledge and capacity for loss. Better still if the questionnaire output leads to a provisional assessment that is adapted as a result of the adviser’s assessment of capacity.
The adviser’s role is simple: tell the client how much risk they need to take to achieve their goals and how much risk they can afford to take.
Chris Gilchrist is director of Fiveways Financial Planning, a contributing author to Taxbriefs Advantage and edits The IRS Report